Pre-money valuation

A pre-money valuation is a term widely used in private equity or venture capital industries, referring to the valuation of a company or asset prior to an investment or financing. If an investment adds cash to a company, the company will have different valuations before and after the investment. The pre-money valuation refers to the company's valuation before the investment.

External investors, such as venture capitalists and angel investors will use a pre-money valuation to determine how much to ask for in return for their cash injection to an entrepreneur and his or her startup company. This is calculated on a fully diluted basis.

Usually, a company receives many rounds of financing (conventionally named Round A, Round B, Round C, etc.) rather than a big lump sum in order to decrease the risk for investors and to motivate entrepreneurs. Pre- and post-money valuation concepts apply to each round.

There are many different methods for valuing a business, but basic formulae include:

Shareholders of Widgets, Inc. own 100 shares, which is 100% of equity. If an investor makes a $10 million investment (Round A) into Widgets, Inc. in return for 20 newly issued shares, the implied post-money valuation is:

This implies a pre-money valuation equal to the post-money valuation minus the amount of the investment. In this case, it is:

The initial shareholders dilute their ownership to 100/120 = 83.33%.

Let's assume that the same Widgets, Inc. gets the second round of financing, Round B. A new investor agrees to make a $20 million investment for 30 newly issued shares. If you follow the example above, it has 120 shares outstanding. Post-money valuation is:

The pre-money valuation is:

The initial shareholders further dilute their ownership to 100/150 = 66.67%.

Upround and downround are two terms associated with pre- and post-money valuations. If the pre-money valuation of the upcoming round is higher than the post-money valuation of the last round, the investment is called an upround. If the pre-money valuation is lower than the post-money valuation of the previous round, then the investment is called a downround. In the above example, Round B was an upround investment, because pre-money B ($80 million) was higher than was post-money A ($60 million).

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